Building Integrated Economies in West Africa

Chapter 26. Foreign Investment in Government Debt

Alexei Kireyev
Published Date:
April 2016
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Patrick Imam

Foreign investment in the West African Economic and Monetary Union (WAEMU) remains limited. Even government debt, the least risky investment instrument, attracts very little attention from nonresident investors, unlike the attention received in neighboring Ghana and Nigeria. Possible reasons for this situation include unattractive nominal interest rates in the region, the relatively small market size, lack of a secondary market, cumbersome exchange controls and regulations, fragmentation of the regional market, insufficient communication on issuances, the language issue, insufficient political stability, and a poor investment climate. To make the regional market more attractive to foreign investors, sound macroeconomic policies and a solid financial sector are prerequisites. Beyond this, communication with nonresidents should be improved with Agence UMOA-Titres playing a key role; development of WAEMU financial markets, including the secondary market for government securities, should be accelerated; market size should be increased by eliminating segmentation of the sovereign bond market; and finally, taxation needs to be harmonized and double taxation avoided.

Participation By Nonresidents

Appetite for sub-Saharan “frontier markets’” debt has been growing in recent years. Since the launch of the Ghana Eurobond in 2007, more and more countries in the region have borrowed overseas in foreign currency (see IMF 2013). A more recent trend has been the increase in purchases of local currency bonds. The profile of investors is also shifting, with traditional niche players increasingly joined by dedicated institutional frontier market funds and large institutional investors, mainly from the United States and the United Kingdom.

There is little evidence of significant investment by nonresidents from outside the WAEMU in the regional government debt market. This is in contrast with the situation in neighboring Ghana and Nigeria. While comprehensive information has not been compiled, available data on Senegal—one of the main issuers on this market—suggest that less than 2.5 percent of its debt issued on the WAEMU market is held by nonresidents (see Figure 26.1). This contrasts with the case in Ghana and Nigeria, where foreign ownership of government debt hovers at around 20 and 25 percent, respectively.

Figure 26.1.Size of Domestic Sovereign Debt Market

Sources: Bloomberg L.P.; Central Bank of West African States (BCEAO); IMF, African Department database.

This situation is surprising, as the WAEMU has characteristics that should make its market attractive to foreign investors, including:

  • High growth—At about 6 percent in 2012 and 2013, and expected to remain robust
  • Sound fundamentals—Fiscal sustainability was restored with debt relief and maintained since through appropriate fiscal policies. Structural reforms have been implemented to improve governance and the business environment.
  • Diversification—Debt issued in the WAEMU is less likely, for instance, to be affected by the fluctuations of key commodity prices, unlike in other sub-Saharan African countries, which are typically dependent on a single commodity.
  • Low foreign exchange risk—The credible peg to the euro reduces the exchange rate risk.
  • Donor support—Remains substantial and cushions the impact of external and fiscal shocks

The View of Foreign Investors

Market participants view the risk-adjusted nominal interest rates on the WAEMU market as unattractive. Investors in frontier markets consider both the yield on domestic debt and the exchange rate. The yields on the WAEMU market are viewed as low—when compared with the yields in other African countries (Figure 26.2)—even once the greater exchange rate stability associated with the exchange regime is taken into account. There is a perception that the regional market does not price risks adequately, a perception also underpinned by the fact that yields across sovereign issuers do not seem to reflect the range of fiscal situations. Yields may be driven down by the lack of alternative investments for domestic banks, which are the main investors on the WAEMU market. Foreign investors are also uncertain about the extent to which solidarity across WAEMU countries could play in the event of a debt crisis. This makes risk pricing more challenging.

Figure 26.2.Interest Rates on Domestic and Foreign Bonds in Selected Countries

Sources: Bloomberg, L.P.; Central Bank of West African States (BCEAO); and Dealogic. Note: Benin 2009 issuance, 7-year maturity; Burkina Faso 2012 issuance, 5-year maturity; Côte d’Ivoire Eurobond 2012 issuance, 20-year maturity; CIV 2013 domestic issuance, 7-year maturity; Guinea-Bissau has not offered long-term bonds the last few years; Mali 2010 issuance, 5-year maturity; Niger 2013 issuance, 5-year maturity; Senegal Eurobond 2011 issuance, 10-year maturity; Togo 2013 issuance, 5-year maturity; Ghana 2013 Eurobond issuance, 10-year maturity; Kenya 2013 issuance, 15-year maturity; Nigeria 2013 issuance, 5-year maturity.

BEN = Benin; BFA = Burkina-Faso; CIV = Côte d’Ivoire; MLI = Mali; NER = Niger; SEN = Senegal; TGO = Togo, GHA = Ghana; KEN = Kenya; NER = Nigeria.

The size of the WAEMU market is too small. The WAEMU market amounts to about 8 percent of the regional GDP. All but one WAEMU countries have issued on the market. Even for the larger issuers (Côte d’Ivoire, Senegal), the outstanding stock of debt on the WAEMU market is relatively small (Figure 26.3). By contrast, Nigeria’s and Ghana’s domestic debt markets are much deeper. Size is important to foreign investors, as it is generally associated with liquidity and better pricing. Small size also means that no debt issued on the WAEMU market is included in Local Currency Bond (LCB) global indices, which bond funds often use to benchmark their exposure. Nigeria was included in 2012 in the JP Morgan Government Bond-Emerging Markets Index, which triggered additional demand for its debt.

Figure 26.3.Size of Domestic Sovereign Debt Market

Sources: Bloomberg, L.P.; Central Bank of West African States (BCEAO); and IMF, African Department database.

Lack of a secondary market is also an issue. Without the ability to sell bonds or bills on a secondary market (including because of the “buy-and hold” strategy of domestic investors), a foreign investor is constrained to hold these instruments until maturity (or perhaps to sell them at a deep discount). As a result, foreign investors will, at best, be interested in short-term paper. The lack of an active secondary market also makes pricing at issuance more difficult.

Exchange control regulations and practices are viewed as cumbersome in the WAEMU. In principle, there are no regulatory obstacles to capital inflows to buy government securities on the WAEMU market, or to the repatriation of proceeds. However, according to investors, observance of rules and regulations on capital flows requires a number of administrative steps and is very burdensome in practice, particularly on the way out. This tends to dissuade capital inflows in the first place. Another concern expressed by investors is that capital repatriation might become even more difficult in the event of a crisis. Investors’ perception is that investing in Ghana or Nigeria is much easier. While Ghana uses macroprudential policies—such as foreigners only being allowed to purchase longer-term paper—and Nigeria has only a few restrictions, the policies in both countries are seen as transparent and not cumbersome.

In the wake of the euro area crisis, investors also mention issues related to currency union architecture. A country in a monetary union does not issue its currency. In the event of a loss of confidence from investors, there may therefore not be a “buyer of last resort” to restore confidence, with a liquidity problem that may turn into a solvency problem (De Grauwe 2011). In the WAEMU, direct financing of governments by the Central Bank of West African States (BCEAO) has been phased out, and there are strict rules on the amount of government paper the BCEAO can accept for bank refinancing purposes. The Financial Stability Fund is expected to play the role of a liquidity backstop for governments in the future, but it is not yet operational.

The regional market for government securities in the WAEMU is fragmented. This does not just refer to the fact that an investor has to choose between eight different sovereigns. Government paper is issued through two different channels: (1) auctions by the BCEAO on the money market, and (2) the regional stock exchange (only longer-term paper). This fragmentation reduces liquidity and raises the costs of investing.

Communication targeting foreign investors is very limited. Until the creation of Agence UMOA-Titres there was no structured communication about the WAEMU market. The only roadshows were done for Eurobonds. Also, the dissemination of economic and financial information by national and regional authorities has been limited until recently, and has generally been exclusively in French. Discussions with investors clearly illustrated that they had limited knowledge or understanding of key developments or institutional arrangements in the WAEMU. A good example of this is the lack of awareness of rules and institutions supporting the exchange rate regime.

Language is another important barrier. Limited English is spoken in francophone Africa, and information and documents are mainly in French. The major international capital markets are, however, Anglophone. Language issues add to the complexity of dealing with legal traditions and institutions with which foreign investors may not be familiar. News flows emanating from francophone African countries are also lower than those from Anglophone African countries, given the dominance of English-speaking news outlets. This creates an additional information gap.

Political stability and the investment climate may be perceived as less favorable than in other frontier markets. As detailed in Chapter 4, which covers growth in the WAEMU, the region tends to have lower scores in these areas in available international surveys. Tax issues may also play a role. Within the Union, interests are subject to taxation for investors who do not reside in the issuing country, with tax rates varying from country to country. A foreign investor can only buy on the WAEMU market by opening a bank account in a WAEMU country. To optimize taxation, an investor interested in all the sovereigns would therefore need to open an account in each of the issuing countries. Double taxation (in the investor’s home country) may also be an issue. Finally, financial infrastructure, rules, and practices (for example, regulations, custody, and settlements) in WAEMU countries may also lag behind those of Anglophone competitors. For instance, custodians and brokers are typically the same entity, though U.S. law requires a separation of these two activities for U.S. investors. The technological platform with real-time pricing only came into effect in 2013.

Reform Priorities

Nonresident investment in the WAEMU market should be sought and increased gradually, while addressing the related risks. Governments have a choice of financing their deficits through domestic and external funds, with different costs and benefits. Tapping external savings increases the resources available to the economy and reduces the risk of crowding out, although it should be recognized that the latter has likely been limited in the WAEMU until recently due to excess liquidity in the banking system. External savings can be tapped by issuing on international markets (for example, Eurobonds) or on the regional market. The advantage of the latter option is that it contributes to the development of the market, which in principle increases liquidity, and reduces costs and a number of risks through a diversification of the investor base. Issuing in local currency also eliminates the exchange rate risk. This type of capital inflow, however, raises other challenges for which the authorities need to prepare. Some foreign investors may be more footloose than domestic ones, and their large size can generate volatility in a small market. This complicates monetary policy, reserve management, and the preserving of financial stability. On balance, however, a gradual move to higher nonresident participation in the WAEMU market is desirable and should be accompanied by adequate safeguards.

A number of steps could be taken by the authorities to increase the attractiveness of the WAEMU market. Sound macroeconomic and financial sector policies are prerequisites, as discussed previously. Beyond this, based on the obstacles described in this chapter, the following measures could be considered:

  • Improve communication with nonresidents—Agence UMOA-Titres will have a key role to play in this area in the short term. The BCEAO has improved its external communication in the past two years and should continue doing so, for instance by publishing English versions of key documents (such as the quarterly reports prepared for the monetary policy council). Governments should also improve the dissemination of key economic and financial information, including in English.
  • Accelerate ongoing reforms to develop the WAEMU market—Significant foreign investment in the WAEMU market is unlikely to take place until the market reaches a larger size and there is a secondary market. The ongoing reforms in this area (and to develop the interbank market) are therefore critical. Another important reform in this area is the establishment of the financial stability fund, which could address some of the liquidity concerns raised by investors.
  • Reduce the segmentation of the sovereign bond market—This would help increase the size of the market and therefore liquidity.
  • Harmonize taxation—This will ensure that foreign investors see the WAEMU market as one single integrated market. Double taxation should also be avoided.

    De GrauwePaul.2011. “Managing a Fragile Eurozone.CESifo Forum12: 4045.

    International Monetary Fund (IMF). 2013. “Issuing International Sovereign Bonds: Opportunities and Challenges for Sub-Saharan Africa.In Regional Economic Outlook.Washington: International Monetary Fund.

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